Expecting this payment processor to deliver 113% growth in the next two years

📈 Trade Details

Option 1:
A straight stock purchase of  PYPL at $79.36 (the price at the time of writing). 

Option 2:
Sell Nov. 1’24 (24 Days Out) Cash-secured Put with a Strike Price of $74 that pays $1.72 premium.

Result: Receive $172 right away.
Cash Collateral Required: $7,400
Return on Collateral: 2.32% in 24 days or 41.74% annualized.

Worst-case scenario: If the price drops to or below $74, I will be forced to buy 100 shares at $7400, even if it drops below $74 in 24 days.

Note: Earnings will be released on October 29th. Given stock volatility, the market can react aggressively to this announcement.

🎯 What do we expect?

If the expected earnings growth materializes, the expected return is 113.24% by 2026 or 40.23% annualized. This gives us a hefty margin of safety to work with. Paypal had a substantial run YTD, but the valuation still seems attractive.

Buying a stock at its 52-week high is sometimes not a bad thing. It all comes down to fair value. Plus, momentum is a real thing that can drive the price higher. We don't focus on or rely on momentum; we focus on the underlying value of each company we buy.

🗒️ Quick Company Summary

NASDAQ Ticker: PYPL

PayPal Holdings, Inc. is a technology platform and digital payments company that enables individuals and businesses to make and receive payments online. The company operates a global payment system that supports various payment methods, including credit cards, debit cards, and bank transfers. Key aspects of PayPal's operations include

💰How does the company make money?

• Transaction Revenue: $28.12 billion (90.64%)

• Other Value-Added Services (OVAS) Revenue: $2.904 billion (9.36%)

• Total: $31.03 billion

🔥 What’s trending in the news right now?

1. Earnings Report Expectations: Analysts are optimistic about PayPal's upcoming earnings report, noting its strong history of beating estimates.

2. Value Stock Comparison: A recent analysis compares PayPal with Palo Alto Networks, focusing on which stock offers better value for investors and PayPal is coming out ahead.

3. Nasdaq-100 Performance: PayPal was highlighted as one of the best-performing stocks in the Nasdaq-100 last quarter, raising questions about its continued investment potential.

🎯 What analysts think (Stock Price Forecast in 1 YR):

Avg. Price: $82.28(+3.6%)
Highest Price:  $125 (+57.5%)
Lowest Price: $16 (-14%)

Wall St. Analysts believe that the stock is fairly priced at this point and that there is little room for growth.

Historically, the stock has traded below analyst targets. So, if we are buying here, we go against market sentiment. It is never a bad thing, but we have to understand where exceptional & unexpected growth will come from.

However, PayPal consistently beats expectations on both Revenue & Earnings each quarter:

🎯 What do financial models think:

Avg. Price: 109.54 (+38%)

Breakdown by Model:

• PB Multiples: $101.99 (28.52%)

• Earnings Power Value: $107.63 (35.62%)

• PS Multiples: $107.63 (35.62%)

• EBITDA Multiples: $96.85 (22.04%)

• P/E Multiples: $96.59 (21.71%)

• Revenue Multiples: $105.80 (33.32%)

• EBIT Multiples: $99.15 (24.94%)

• 5Y DCF EBITDA Exit: $115.75 (45.85%)

• 5Y DCF Revenue Exit: $121.44 (53.02%)

• 10Y DCF Revenue Exit: $125.11 (57.65%)

• 10Y DCF EBITDA Exit: $117.08 (47.53%)

• 10Y DCF Growth Exit: $117.57 (48.15%)

With the stock trading at a modest 18x Forward P/E and consistently beating expectations, I believe analysts are underplaying its future potential. 

🕰️ Historical Performance vs. S&P500 ($10k Investment)

Here is the summary of your returns if you invested $10,000 in PYPL vs. S&P 500 since 2021. 

What the hell happened?

At its peak in 2021, the stock was trading at a PE of 72 when its usual Norma P/E was around 30 (Blue Line). COVID years saw a boom in everything that was "online," which drove demand for transaction services that drove valuations to crazy levels. Crazy because the earnings between 2019 and 2021 did not grow at an absurd level that would justify just a drastic increase in stock price.

🔮 Future Earnings Expectations

Analysts expect earnings to start growing in 2025:

What are they missing:

• Strong Financial Performance: PayPal's Q2 results showed significant growth in revenue, net income, and other key financial metrics, exceeding expectations. Revenue grew by 8.2%, and payment transactions hit a record high, indicating a robust recovery.

• User Growth and Engagement: After a period of decline, PayPal's active accounts have started increasing again, reaching 429 million in Q2. Additionally, users are engaging more, with the number of transactions per active account hitting its highest level ever. This suggests that PayPal’s user base is becoming more active and valuable.

• Record Payment Volume: The company achieved a record total payment volume (TPV) of $416.81 billion in Q2, driven by growth across all categories, including U.S., international, peer-to-peer, and Venmo transactions. These increases reflect broad and sustainable growth.

• Improved Cash Flow and Profit Margins: PayPal reported a significant turnaround in operating cash flow and expanded its EBITDA. The company’s strong cash flow margins, along with an increase in guidance for the year, indicate that its profitability is stronger than analysts anticipated.

• Valuation and Share Buybacks: PayPal remains undervalued based on its price-to-earnings, price-to-cash-flow, and enterprise value to EBITDA ratios compared to its peers. Additionally, the company's aggressive share buyback program creates additional value for investors, further supporting the case for a higher valuation.

• Innovation and Partnerships: The company’s strategic moves, such as expanding cryptocurrency services, partnering with Amazon for payment integration, and launching new solutions like Fastlane, demonstrate its ability to innovate and grow. These initiatives are expected to drive future earnings and growth beyond what analysts currently predict.

🚚 Key Drivers of Future Growth

1. Meta Partnership:

   • PayPal continues to deepen its partnership with Meta, where PayPal is a top payment method for advertisers and consumers across Meta's family of apps. This includes:

     • Meta's donations and charitable giving campaigns running on the PayPal Giving Fund platform.

     • Payments to creators and developers using Hyperwallet.

     • Credit card processing through Braintree.

   • PayPal aims to optimize experiences with Meta and looks forward to further collaboration.

2. DoorDash Contract Renewal:

   • PayPal renewed its contract with DoorDash, expanding their collaboration beyond unbranded payment service provider (PSP) processing. DoorDash will also participate as an initial launch partner for PayPal's latest branded checkout enhancements and the new ads platform.

3. Fastlane Launch:

   • Fastlane, a new checkout solution, is being made generally available to merchants in the U.S. in August 2024. It includes partnerships with platforms like Salesforce, Adobe, and BigCommerce, enhancing the checkout experience for consumers.

4. Venmo Partnerships:

   • Venmo is expanding its partnerships with merchants, including eBay and StubHub, to enhance the Pay with Venmo feature, which is expected to drive growth in transaction volume.

5. In-App Offers:

   • PayPal launched in-app offers with major brands such as Best Buy, Priceline, Lyft, Instacart, Ticketmaster, Walmart, and Nordstrom, aiming to increase consumer engagement and drive gross merchandise volume.

🐂 Key Bullish Arguments

1. Strong Revenue and Profit Growth: PayPal's Q2 results demonstrated significant growth, including an 8.2% increase in revenue and a record total payment volume of $416.81 billion. The company also achieved higher net income and operating cash flow, indicating a strong financial foundation.

2. Increasing User Engagement: After a period of declining active accounts, PayPal saw growth in its user base, reaching 429 million active accounts in Q2. Additionally, transactions per active account reached a historical high, reflecting higher user engagement and loyalty.

3. Undervaluation Relative to Peers: The author argues that PayPal's stock is undervalued compared to similar companies, based on metrics like price-to-earnings and price-to-cash-flow ratios. This presents an opportunity for upside as the market corrects this mispricing.

4. Share Buyback Program: PayPal’s aggressive share repurchase strategy adds value to shareholders, with management buying back shares at favorable prices, enhancing per-share earnings and overall investor returns.

5. Innovative Initiatives and Strategic Partnerships: PayPal’s expansion into cryptocurrency services, partnership with Amazon for payment solutions, and launch of new products like Fastlane showcase its ability to innovate and capitalize on growth opportunities. These initiatives are expected to enhance revenue streams and drive future growth.

6. Increased Earnings Guidance: Due to the company’s strong financial performance, management has raised earnings guidance for the year, signaling confidence in PayPal’s ongoing growth and profitability.

🐻 Key Bearish Arguments

• Past Decline in Active Accounts: Although PayPal has recently shown an uptick in active accounts, the prior decline in user numbers could indicate potential difficulties in maintaining or growing its user base long-term. This past trend remains a concern for the company’s future growth prospects.

• Market Sentiment and Volatility: PayPal’s stock experienced a significant decline of 10.1% earlier in the year despite the overall market moving upward. This volatility reflects broader market skepticism and could signal that investor sentiment may not fully align with the company’s fundamentals, leading to continued stock price fluctuations.

• Competitive Landscape: The payment processing industry is highly competitive, with major players like Square, Stripe, and traditional financial institutions offering similar or advanced services. PayPal must continue innovating and adapting to stay ahead, but there is always a risk that competitors may outpace its efforts.

• Execution Risks in New Initiatives: While PayPal has launched several new initiatives like cryptocurrency services, Fastlane, and partnerships with Amazon and Adyen, there are risks associated with the successful implementation and adoption of these innovations. Any failure or delay could negatively impact growth projections.

• Economic and Market Conditions: Changes in macroeconomic factors such as rising interest rates, inflation, or a broader economic downturn could negatively affect consumer spending and transaction volumes, impacting PayPal’s revenue growth.

Risks Highlighted by Management in the latest Earnings Call:

Summary Table of Key Risks

Conclusion

I love a turnaround story and market is picking up on it. This could be the beginning of PayPal coming back to strong growth. User growth trend is very appealing and company is very attractively valued compared to pears. With a margin of safety expected, even if the company delivers half of what is expected its fair valuation should is 50% higher than it is now in 2 years time. 

Disclaimer
I currently do not have an active position in any of the companies mentioned above but am thinking of initializing in the next few days. As usual, the information provided in this newsletter is for general informational purposes only. All information in the newsletter is provided in good faith, however, we make no representation or warranty of any kind, express or implied, regarding the accuracy, adequacy, validity, reliability, availability, or completeness of any information. The content of this newsletter does not constitute financial advice, investment advice, or any other type of advice and should not be relied upon for any individual circumstances. We are not financial advisors, and you should consult with a professional before making any investment decisions. Any action you take upon the information in this newsletter is strictly at your own risk, and we will not be liable for any losses and/or damages in connection with the use of our newsletter.

Happy Investing,
Andy